Pillar 3 report Table of contents

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2 Table of contents Structure of Pillar 3 report Executive summary 3 Introduction 5 Risk appetite and risk types 6 Controlling and managing risk 7 Group structure 13 Capital overview 15 Leverage ratio 19 Credit risk management 21 Credit risk exposures 29 Credit risk mitigation 54 Counterparty credit risk 57 Securitisation 60 Market risk 70 Liquidity risk management 74 Liquidity coverage ratio 75 Net stable funding ratio 76 Operational risk 78 Equity risk 80 Interest Rate Risk in the Banking Book 82 Remuneration 84 Appendices Appendix I Regulatory capital reconciliation 91 Appendix II Entities included in regulatory consolidation 97 Appendix III Level 3 entities asset and liabilities 100 Appendix IV Regulatory expected loss 101 Appendix V APS330 quantitative requirements 102 Glossary 105 Disclosure regarding forward-looking statements 110 In this report references to Westpac, Westpac Group, the Group, we, us and our are to Westpac Banking Corporation and its controlled entities (unless the context indicates otherwise). In this report, unless otherwise stated or the context otherwise requires, references to '$', 'AUD' or 'A$' are to Australian dollars. Any discrepancies between totals and sums of components in tables contained in this report are due to rounding. In this report, unless otherwise stated, disclosures reflect the Australian Prudential Regulation Authority s (APRA) implementation of Basel III. Information contained in or accessible through the websites mentioned in this report does not form part of this report unless we specifically state that it is incorporated by reference and forms part of this report. All references in this report to websites are inactive textual references and are for information only. 2 Westpac Group September 2018 Pillar 3 report

3 Executive summary 30 September March September 2017 The Westpac Group at Level 2 Common equity Tier 1 (CET1) capital after deductions $m 45,239 43,639 42,670 Risk w eighted assets (RWA) $m 425, , ,235 Common equity Tier 1 capital ratio % Additional Tier 1 capital % Tier 1 capital ratio % Tier 2 capital % Total regulatory capital ratio % APRA leverage ratio % Westpac s common equity Tier 1 (CET1) capital ratio was 10.63% at 30 September 2018, up 13 basis points from 31 March The increase was principally due to 20 basis points of organic capital growth and conversion of some preference shares (14 basis point increase), with these items partially offset by regulatory measurement changes of 30 basis points for mortgage risk weights and operational risk RWA. 90bps 10.50% (68bps) 3bps (5bps) 14bps 5bps 4bps 10.63% (30bps) Organic (+20bps) Other items (-7bps) 31 Mar 2018 Cash earnings Interim dividend (net of DRP) Ordinary RWA growth Other capital movements Impact of RWA model changes $566m residual CPS converted Exit of investments FX translation impact 30 Sep 2018 Organic capital generation of 20 basis points included: Second Half 2018 cash earnings of $3.8 billion (90 basis point increase); The 2018 interim dividend payment, net of DRP share issuance (68 basis point decrease); Ordinary RWA (before FX movements and regulatory measurement changes) fell slightly, with growth being offset by improvements in credit quality (3 basis point increase); and A 5 basis point reduction from other capital movements. Other items, in aggregate, reduced the CET1 capital ratio by 7 basis points. Regulatory measurement changes impacting mortgages and operational risk RWA (30 basis point decrease) were mostly offset by the conversion of $566 million of convertible preference shares to ordinary shares (14 basis point increase), the exit of Hastings and reduction in equity investments in Ascalon (5 basis point increase) and foreign currency translation impacts (4 basis point increase). $m 30 September March September 2017 Risk w eighted assets Credit risk 362, , ,258 Market risk 6,723 7,406 8,094 Operational risk 39,113 30,866 31,229 Interest rate risk in the banking book 12,989 12,875 11,101 Other 3,810 3,206 4,553 Total RWA 425, , ,235 Total Exposure at Default 1,021,926 1,013, ,853 Westpac Group September 2018 Pillar 3 report 3

4 Executive summary Risk Weighted Assets Total RWA increased $9.6 billion this half: Credit risk RWA increased $1.4 billion or 0.4% from: Regulatory modelling updates to mortgage probability of default models increased mortgage RWA by $4.1 billion; Portfolio growth (mostly mortgages) added $1.5 billion to RWA; Credit quality improvements, mainly for mortgages, decreased RWA by $3.4 billion; Foreign currency translation impacts, mainly related to NZ$ lending, decreased RWA by $0.4 billion; and Decrease in mark-to-market related credit risk RWA of $0.4 billion. Non-credit RWA increased $8.2 billion or 15.2%, mostly from a $7.5 billion increase in operational risk RWA as we introduced a model overlay to approximate the standardised approach. Exposure at Default Over the half, exposure at default (EAD) increased $8.6 billion (up 0.8%), primarily due to growth in residential mortgage exposures of $5.7 billion and sovereign exposures associated with liquid assets of $2.7 billion. Leverage Ratio The leverage ratio represents the amount of Tier 1 capital relative to exposure 1. At 30 September 2018, Westpac s leverage ratio was 5.8%, up 9 basis points since 31 March Liquidity Coverage Ratio (LCR) The LCR requires banks to hold sufficient high-quality liquid assets (HQLA), as defined in APS210 Liquidity, to withstand 30 days under a regulatory-defined acute stress scenario. Westpac s LCR as at 30 September 2018 was 133% (31 March 2018: 134%) and the average LCR for the quarter ending 30 September 2018 was 131% 2. Net Stable Funding Ratio (NSFR) Westpac is required to maintain a NSFR, designed to encourage longer-term funding resilience, of at least 100%. The NSFR came into effect for Australian ADIs on 1 January Westpac had a NSFR of 114% at 30 September 2018 (31 March 2018: 112%). Improvement in the ratio since 31 March 2018 mainly reflects growth in customer deposits and higher capital balances. 1 As defined under Attachment D of APS110: Capital Adequacy 2 Calculated as a simple average of the daily observations over the 30 September 2018 quarter. 4 Westpac Group September 2018 Pillar 3 report

5 Introduction Westpac Banking Corporation is an Authorised Deposit-taking Institution (ADI) subject to regulation by APRA. APRA has accredited Westpac to apply advanced models permitted by the Basel III global capital adequacy regime to the measurement of its regulatory capital requirements. Westpac uses the Advanced Internal Ratings- Based approach (Advanced IRB) for credit risk and the Advanced Measurement Approach (AMA) for operational risk. In accordance with APS330 Public Disclosure, financial institutions that have received this accreditation, such as Westpac, are required to disclose prudential information about their risk management practices on a semi-annual basis. A subset of this information must be disclosed quarterly. This report describes Westpac s risk management practices and presents the prudential assessment of Westpac s capital adequacy as at 30 September In addition to this report, the regulatory disclosures section of the Westpac website 1 contains the reporting requirements for: Capital instruments under Attachment B of APS330; and The identification of potential Global-Systemically Important Banks (G-SIB) under Attachment H of APS330 (disclosed annually). Capital instruments disclosures are updated when: A new capital instrument is issued that will form part of regulatory capital; or A capital instrument is redeemed, converted into CET1 capital, written off, or its terms and conditions are changed. 1 Westpac Group September 2018 Pillar 3 report 5

6 Pillar 3 Report Risk appetite and risk types The Westpac Group s vision is to be one of the world's great service companies, helping our customers, communities and people to prosper and grow. The Westpac Group s appetite for risk is informed by our planned business strategy, regulatory rules and ratios, and the potential for adverse outcomes to result in material impacts on our customers, our staff, our reputation, our regulatory relationships and our financial position. The Westpac Group distinguishes between different types of risk and takes an integrated approach toward identifying, assessing and managing all risks including through the annual review of the Westpac Group Risk Management Strategy and the establishment of additional controls through supporting frameworks and policies. Overview of key risk types credit risk - the risk of financial loss where a customer or counterparty fails to meet their financial obligations to the Group; liquidity risk - the risk that the Group will be unable to fund assets and meet obligations as they become due; market risk - the risk of an adverse impact on earnings resulting from changes in market factors, such as foreign exchange rates, interest rates, commodity prices and equity prices. This includes interest rate risk in the banking book - the risk to interest income from a mismatch between the duration of assets and liabilities that arises in the normal course of business activities; operational risk - the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition is aligned to the regulatory (Basel II) definition, including legal and regulatory risk but excluding strategic risk; conduct risk - the risk that the provision of our services and products results in unsuitable or unfair outcomes for our stakeholders or undermines market integrity; compliance risk - the risk of legal or regulatory sanction, financial or reputational loss, arising from our failure to abide by the compliance obligations required of us; business risk - the risks arising from our strategic objectives and business plans; sustainability risk - the risk of reputational or financial loss due to failure to recognise or address material existing or emerging sustainability related environmental, social or governance issues; equity risk - the potential for financial loss arising from movements in equity values. Equity risk may be direct, indirect or contingent; insurance risk - the risk in our insurance entities of claims costs being greater than expected, due to a failure in product design, underwriting, reinsurance arrangements or an increase in severity and frequency of insured events; related entity (contagion) risk - the risk that problems arising in other Westpac Group members compromise the financial and operational position of the authorised deposit-taking institution in the Westpac Group; and reputation risk - the risk of the loss of reputation, stakeholder confidence, or public trust and standing. 6 Westpac Group September 2018 Pillar 3 report

7 Controlling and managing risk We have adopted a Three Lines of Defence approach to risk management which reflects our culture of risk is everyone s business in which all employees are responsible for identifying and managing risk and operating within the Group's desired risk profile. Effective risk management enables us to: accurately measure our risk profile and balance risk and reward within our risk appetite, optimising financial growth opportunities and mitigating potential loss or damage; protect Westpac Group s depositors, policyholders and investors by maintaining a balance sheet with sound credit quality and buffers over regulatory minimums; deliver suitable, fair and clear outcomes for our customers that support market integrity; embed adequate controls to guard against excessive risk or undue risk concentration; and meet our regulatory and compliance obligations. The Board is responsible for approving the Westpac Group Risk Management Strategy and Westpac Group Risk Appetite Statement and for monitoring the effectiveness of risk management by the Westpac Group. The Board has delegated to the Board Risk & Compliance Committee responsibility to review and recommend the Westpac Group Risk Management Strategy and Westpac Group Risk Appetite Statement to the Board for approval; set risk appetite consistent with the Westpac Group Risk Appetite Statement; approve frameworks, policies and processes for managing risk (consistent with the Westpac Group Risk Management Strategy and Westpac Group Risk Appetite Statement); and review and, where appropriate, approve risks beyond the approval discretion provided to management. Risk management governance structure Board approves our overall Westpac Group Risk Management Strategy and the Westpac Group Risk Appetite Statement; and Board Risk & Compliance Committee (BRCC) makes annual declaration to APRA on risk management. reviews and recommends the Risk Management Strategy and Westpac Group Risk Appetite Statement to the Board for approval; reviews and monitors the risk profile and controls of the Group consistent with the Westpac Group Risk Appetite Statement; reviews and approves the frameworks, policies and processes for managing risk; reviews and approves the limits and conditions that apply to credit risk approval authority delegated to the Chief Executive Officer (CEO), Chief Financial Officer (CFO) and Chief Risk Officer (CRO) and any other officers of the Westpac Group to whom the Board has delegated credit approval authority; monitors the alignment of the Westpac Group s risk profile and controls with risk appetite, and oversees the identification, management and reporting of our risks inherent in the Westpac Group s operations; monitors changes anticipated for the economic and business environment including consideration of emerging risks, and other factors considered relevant to our risk profile and risk appetite; assists the Board to make its annual declaration to APRA on risk management under APRA prudential standard CPS220 Risk Management; reviews and where appropriate approves risks beyond the approval discretion provided to management; and assists the Board to oversee compliance management within the Group. From the perspective of specific types of risk, the Board Risk & Compliance Committee s role includes: credit risk approving key policies and limits supporting the Credit Risk Management Framework, and monitoring the risk profile, performance and management of our credit portfolio; liquidity risk approving key policies and limits supporting the Liquidity Risk Management Framework, including our annual funding strategy, recovery and resolution plans and monitoring the liquidity position and requirements; Westpac Group September 2018 Pillar 3 report 7

8 Controlling and managing risk Risk management governance structure (continued) market risk approving key policies and limits supporting the Market Risk Management Framework, including, but not limited to, the Value at Risk limits and Net Interest Income at Risk limits and monitoring the market risk profile; operational risk approving key policies supporting both the Operational Risk Management Framework and the Financial Crime Risk Management Framework, and monitoring the performance of operational and financial crime risk management and controls; conduct risk reviewing and approving the Westpac Group Conduct Framework and reviewing and monitoring the performance of conduct risk management and controls; reputation risk reviewing and approving the Reputation Risk Management Framework, and reviewing and monitoring the performance of reputation risk management and controls; and compliance risk reviewing and approving the Westpac Group Compliance Risk Management Framework and reviewing compliance processes and our compliance with applicable laws, regulations and regulatory requirements, discussing with management and the external auditor any material correspondence with regulators or government agencies and any published reports that raise material issues and reviewing complaints and whistleblower concerns. The Board Risk & Compliance Committee also: oversees and approves the Internal Capital Adequacy Assessment Process and in doing so reviews the outcomes of Westpac Group stress testing, sets the target capital ranges for regulatory capital and reviews and monitors capital levels for consistency with the Westpac Group s risk appetite; provides relevant periodic assurances and reports (as appropriate) to the Board Audit Committee; reviews and approves other risk management frameworks 1 and the monitoring of performance under those frameworks (as appropriate); forms a view on Westpac Group s risk culture and oversees the identification of, and steps taken to address, any desirable changes to risk culture and periodically reports to the Board; refers to the Board or any other Board Committees any matters that come to the attention of the Board Risk & Compliance Committee that are relevant for the Board or the respective Board Committees; and in its capacity as the Westpac Group s US Risk Committee, oversees the key risks, risk management framework and policies of Westpac Group s US operations. Board Committees with a Risk Focus Board Audit Committee (BAC) oversees the integrity of financial statements and financial reporting systems and matters relating to taxation risks. Board Remuneration Committee (BRC) oversees remuneration policies and practices of the Westpac Group, in the context that these policies and practices reflect Westpac s risk management framework, including making recommendations to the Board for the reduction or lapsing of incentive based equity grants to employees as a result of risk or compliance failures. Board Technology Committee (BTC) oversees the implementation of the Westpac Group s technology strategy, including risks associated with major technology programs. 1 Additional frameworks include the Sustainability Risk Management Framework, Equity Risk Management Framework, Related Entity Risk Management Framework, Financial Crime Risk Management Framework, and Insurance Risk Management Framework. 8 Westpac Group September 2018 Pillar 3 report

9 Controlling and managing risk Risk management governance structure (continued) Executive Team Executive risk committees Westpac Executive Team (ET) executes the Board-approved strategy; delivers the Westpac Group s various strategic and performance goals within the approved risk appetite; and monitors key risks within each business unit, capital adequacy and the Westpac Group s reputation. Westpac Group Executive Risk Committee (RISKCO) leads the management and oversight of material risks across the Westpac Group within the context of the risk appetite approved by the Board; oversees the embedding of the Risk Management Strategy in the Group's approach to risk governance; oversees risk-related management frameworks and key supporting policies; oversees the Group s material risks; oversees reputation risk and sustainability risk management frameworks, compliance and conduct management frameworks and key supporting policies; and identifies emerging credit, operational, compliance and market risks and allocates responsibility for assessing impacts and implementing appropriate actions to address these. Westpac Group Asset & Liability Committee (ALCO) leads the optimisation of funding and liquidity risk-reward across the Group; reviews the level and quality of capital to ensure that it is commensurate with the Group s risk profile, business strategy and risk appetite; oversees the Liquidity Risk Management Framework and key policies; oversees the funding and liquidity risk profile and balance sheet risk profile; and identifies emerging funding and liquidity risks and appropriate actions to address these. Westpac Group Credit Risk Committee (CREDCO) leads the optimisation of credit risk-reward across the Group; reviews and oversees the Credit Risk Management Framework and key supporting policies; oversees Westpac s credit risk profile; and identifies emerging credit risks, allocates responsibility for assessing impacts, and responds as appropriate. Westpac Group Market Risk Committee (MARCO) leads the optimisation of market, equity and insurance risk across the Group; reviews and oversees the Market Risk, Equity Risk and Insurance Risk Management Frameworks and key market risk management policies; reviews policies and limits for managing traded and non-traded market risk; and reviews and oversees the market risk, equity risk and insurance risk profile. Westpac Group September 2018 Pillar 3 report 9

10 Controlling and managing risk Risk management governance structure (continued) Westpac Group Operational Risk and Financial Crime Committee (OFCO) leads the optimisation of operational risk across the Group; reviews and oversees the Operational Risk and Financial Crime Risk Management Frameworks and key supporting policies; oversees Westpac s operational risk and financial crime risk profile; and identifies emerging operational and financial crime risks, and appropriate actions to address these. Westpac Group Remuneration Oversight Committee (ROC) provides assurance that the remuneration arrangements across the Group are considered from a Human Resources, Risk, Finance, Legal and Compliance perspective in line with external requirements; reviews and makes recommendations to the CEO for recommendation to the BRC on the Westpac Group Remuneration Policy and provides assurance that remuneration arrangements across the Group encourage behaviour that supports Westpac s long-term financial soundness and the Risk Management Framework; reviews and monitors the remuneration arrangements (other than for Group Executives) for Responsible Persons (as defined in the Group Fit and Proper Policy), risk and financial control employees, and all other employees for whom a significant portion of total remuneration is based on performance and whose activities, either individually or collectively, may affect the financial soundness of Westpac; and reviews and recommends to the CEO for recommendation to the BRC the criteria and rationale for determining the total quantum of the Group variable reward pool. Risk and Compliance functions Risk Function assists the Board, Board Committees and senior management to establish, maintain and review the Risk Management Strategy, supporting risk management frameworks and policies and risk appetite; documents and monitors risk appetite across all risk types and classes (including financial crime), risk limits and authorities; notifies the Board or Board Committees of any significant breach, or material deviation from the Risk Management Strategy, supporting risk management frameworks and policies or risk appetite; monitors and provides advice on risk policies, procedures, incidents and issues including emerging risk issues; monitors and provides assurance including testing risk controls as the 2nd Line of Defence; monitors and maintains the required resources and capabilities (including Risk systems and Risk data) to support the Risk Management Strategy; and oversees the management of credit risk and making credit decisions in accordance with delegations from the Board. Compliance Function assists the Board, Board Committees and senior management to establish, maintain and review the Compliance Management Framework; designs, implements and monitors key compliance processes and controls in support of the Compliance Management Framework; 10 Westpac Group September 2018 Pillar 3 report

11 Controlling and managing risk Risk management governance structure (continued) provides independent advice on the design, implementation, operating effectiveness and monitoring of controls to ensure compliance with internal, regulatory and legislative requirements; directs the review and development of compliance policies, compliance plans, controls and procedures; reports on the performance of the Compliance Management Framework; and maintains resources with the skills and tools required to fulfill their compliance responsibilities and supports the strategy. Independent internal review Divisional business units Group Audit reviews the adequacy and effectiveness of management controls over risk. Business Units responsible for identifying, evaluating and managing the risks that they originate within approved risk appetite and policies; and establish and maintain appropriate risk management and compliance controls, resources and self-assessment processes. Westpac Group September 2018 Pillar 3 report 11

12 Controlling and managing risk Roles and responsibilities Our approach to risk management is that risk is everyone s business and that responsibility and accountability for risk begins with the business units that originate the risk. The 1st Line of Defence Risk identification, risk management and self-assessment Divisional business units are responsible for identifying, evaluating and managing the risks that they originate within approved risk appetite and policies. They are required to establish and maintain appropriate risk management controls, resources and self-assessment processes. The 2nd Line of Defence Establishment of risk management frameworks and policies and risk management oversight Risk and compliance advisory, control assurance, and monitoring functions establish frameworks, policies, limits, and processes for the management, monitoring, and reporting of risk. The 2nd Line evaluates and provides assurance over the adequacy and effectiveness of 1st Line controls and application of frameworks and policies and monitors the 1st Line's progress toward remediation of identified deficiencies. The 2 nd Line can also approve certain risks outside the authorities granted to the 1 st Line. The 3rd Line of Defence Independent assurance Group Audit is an independent assurance function that evaluates and opines on the adequacy and effectiveness of both 1st and 2nd Line risk management approaches and tracks remediation progress, with the aim of providing the Board, and senior executives with comfort that the Group s governance, risk management and internal controls are operating effectively. Our overall risk management approach is summarised in the following diagram: Divisional risk appetite and policies Group-wide risk appetite and frameworks Group - wide policies and standards BOARD 2 nd LINE Risk and Compliance Committees Risk Management Function Compliance Function 1 st LINE Business Units (Risk origination within Risk Appetite) Risk Reporting Risk acceptance and monitoring 3 rd LINE Independent assurance Risk identification, evaluation and management 12 Westpac Group September 2018 Pillar 3 report

13 Group Structure Westpac seeks to ensure that it is adequately capitalised at all times. APRA applies a tiered approach to measuring Westpac s capital adequacy 1 by assessing financial strength at three levels: Level 1, comprising Westpac Banking Corporation and its subsidiary entities that have been approved by APRA as being part of a single 'Extended Licensed Entity' (ELE) for the purposes of measuring capital adequacy; Level 2, the consolidation of Westpac Banking Corporation and all its subsidiary entities except those entities specifically excluded by APRA regulations. The head of the Level 2 group is Westpac Banking Corporation; and Level 3, the consolidation of Westpac Banking Corporation and all its subsidiary entities. Unless otherwise specified, all quantitative disclosures in this report refer to the prudential assessment of Westpac s financial strength on a Level 2 basis 2. The Westpac Group The following diagram shows the Level 3 conglomerate group and illustrates the different tiers of regulatory consolidation. Westpac Banking Corporation Westpac Level 1 subsidiaries Westpac New Zealand Ltd Other Westpac Level 2 subsidiaries Regulatory non-consolidated subsidiaries Level 1 Consolidation Level 2 Consolidation Level 3 Consolidation Accounting consolidation 3 The consolidated financial statements incorporate the assets and liabilities of all subsidiaries (including structured entities) controlled by Westpac. Westpac and its subsidiaries are referred to collectively as the Group. The effects of all transactions between entities in the Group are eliminated. Control exists when the parent entity is exposed to, or has rights to, variable returns from its involvement with an entity, and has the ability to affect those returns through its power over that entity. Subsidiaries are fully consolidated from the date on which control commences and they are no longer consolidated from the date that control ceases. Group entities excluded from the regulatory consolidation at Level 2 Regulatory consolidation at Level 2 covers the global operations of Westpac and its subsidiary entities, including other controlled banking, securities and financial entities, except for those entities involved in the following business activities: insurance; acting as manager, responsible entity, approved trustee, trustee or similar role in relation to funds management; non-financial (commercial) operations; or special purpose entities to which assets have been transferred in accordance with the requirements of APS120 Securitisation. Retained earnings and equity investments in subsidiary entities excluded from the consolidation at Level 2 are deducted from capital, with the exception of securitisation special purpose entities. 1 APS110 Capital Adequacy outlines the overall framework adopted by APRA for the purpose of assessing the capital adequacy of an ADI. 2 Impaired assets and provisions held in Level 3 entities are excluded from the tables in this report. 3 Refer to Note 35 of Westpac s 2018 Annual Report for further details. Westpac Group September 2018 Pillar 3 report 13

14 Group structure Subsidiary banking entities Westpac New Zealand Limited (WNZL), a wholly owned subsidiary entity, is a registered bank incorporated in New Zealand and regulated by the Reserve Bank of New Zealand. WNZL uses the Advanced IRB approach for credit risk and the AMA for operational risk. Other subsidiary banking entities in the Group include Westpac Bank-PNG- Limited and Westpac Europe Limited. For the purposes of determining Westpac s capital adequacy subsidiary banking entities are consolidated at Level 2. Restrictions and major impediments on the transfer of funds or regulatory capital within the Group Minimum capital ( thin capitalisation ) rules Tax legislation in most jurisdictions in which the Group operates prescribes minimum levels of capital that must be retained in that jurisdiction to avoid a portion of the interest costs incurred in the jurisdiction ceasing to be tax deductible. Capital for these purposes includes both contributed capital and non-distributed retained earnings. Westpac seeks to maintain sufficient capital/retained earnings to comply with these rules. Tax costs associated with repatriation Repatriation of retained earnings (and capital) may result in tax being payable in either the jurisdiction from which the repatriation occurs or Australia on receipt of the relevant amounts. This cost would reduce the amount actually repatriated. Intra-group exposure limits Exposures to related entities are managed within the prudential limits prescribed by APRA in APS222 Associations with Related Entities 1. Westpac has an internal limit structure and approval process governing credit exposures to related entities. This limit structure and approval process, combined with APRA s prudential limits, is designed to reduce the potential for unacceptable contagion risk. Prudential regulation of subsidiary entities Certain subsidiary banking, insurance and trustee entities are subject to local prudential regulation in their own right, including capital adequacy requirements and investment or intra-group exposure limits. Westpac seeks to ensure that its subsidiary entities are adequately capitalised and adhere to regulatory requirements at all times. There are no capital deficiencies in subsidiary entities excluded from the regulatory consolidation at Level 2. On 15 November 2017, the RBNZ advised WNZL of changes to its conditions of registration resulting from its review of WNZL s compliance with the RBNZ s Capital Adequacy Framework (Internal Models Based Approach) (BS2B). The changes to WNZL s conditions of registration came into effect on 31 December 2017 and increase the minimum Total Capital ratio, Tier 1 Capital ratio and Common Equity Tier 1 Capital ratio of WNZL and its controlled entities by 2%. WNZL has also undertaken to the RBNZ to maintain the Total Capital ratio of WNZL and its controlled entities above 15.1%. WNZL and its controlled entities retain an appropriate amount of capital to comply with the increased minimum ratios. 1 For the purposes of APS222, subsidiaries controlled by Westpac, other than subsidiaries that form part of the ELE, represent related entities. Prudential and internal limits apply to intra-group exposures between the ELE and related entities, both on an individual and aggregate basis. 14 Westpac Group September 2018 Pillar 3 report

15 Capital overview Capital Structure This table shows Westpac s capital resources under APS111 Capital Adequacy: Measurement of Capital. 30 September 31 March 30 September $m Common equity Tier 1 capital Paid up ordinary capital 36,054 35,168 34,889 Treasury shares (507) (506) (436) Equity based remuneration 1,441 1,414 1,356 Foreign currency translation reserve (379) (522) (558) Accumulated other comprehensive income (11) (14) 15 Non-controlling interests - other Retained earnings 27,883 27,122 26,100 Less retained earnings in life and general insurance, funds management and securitisation entities (1,218) (1,238) (1,153) Deferred fees Total common equity Tier 1 capital 63,576 61,728 60,520 Deductions from common equity Tier 1 capital Goodw ill (excluding funds management entities) (8,644) (8,656) (8,670) Deferred tax assets (1,169) (1,116) (1,110) Goodw ill in life and general insurance, funds management and securitisation entities (942) (1,032) (1,065) Capitalised expenditure (1,838) (1,867) (1,913) Capitalised softw are (1,792) (1,628) (1,603) Investments in subsidiaries not consolidated for regulatory purposes (1,567) (1,532) (1,589) Regulatory expected loss in excess of eligible provisions 1 (1,312) (1,192) (861) General reserve for credit losses adjustment (356) (339) (332) Securitisation Equity investments (570) (680) (679) Defined benefit superannuation fund surplus (78) - - Regulatory adjustments to fair value positions (68) (46) (27) Other Tier 1 deductions (1) (1) (1) Total deductions from common equity Tier 1 capital (18,337) (18,089) (17,850) Total common equity Tier 1 capital after deductions 45,239 43,639 42,670 Additional Tier 1 capital Basel III complying instruments 9,144 9,041 7,315 Basel III transitional instruments ,190 Total Additional Tier 1 capital 9,144 9,607 8,505 Net Tier 1 regulatory capital 54,383 53,246 51,175 Tier 2 capital Basel III complying instruments 8,025 8,102 7,375 Basel III transitional instruments ,526 Eligible general reserve for credit loss Basel III transitional adjustment Total Tier 2 capital 8,565 8,630 8,952 Deductions from Tier 2 capital Investments in subsidiaries not consolidated for regulatory purposes (140) (140) (140) Holdings of ow n and other financial institutions Tier 2 capital instruments (93) (83) (77) Total deductions from Tier 2 capital (233) (223) (217) Net Tier 2 regulatory capital 8,332 8,407 8,735 Total regulatory capital 62,715 61,653 59,910 1 An explanation of the relationship between this deduction, regulatory expected loss and provisions for impairment charges is contained in Appendix IV. Westpac Group September 2018 Pillar 3 report 15

16 Capital overview Capital management strategy Westpac s approach to capital management seeks to balance the fact that capital is an expensive form of funding with the need to be adequately capitalised as an ADI. Westpac considers the need to balance efficiency, flexibility and adequacy when determining sufficiency of capital and when developing capital management plans. Westpac evaluates these considerations through an Internal Capital Adequacy Assessment Process (ICAAP), the key features of which include: the development of a capital management strategy, including consideration of regulatory minimums, capital buffers and contingency plans; consideration of both economic and regulatory capital requirements; a stress testing framework that challenges the capital measures, coverage and requirements including the impact of adverse economic scenarios; and consideration of the perspectives of external stakeholders including rating agencies and equity and debt investors. In light of APRA s announcement on unquestionably strong capital benchmarks on 19 July 2017, Westpac will seek to operate with a CET1 capital ratio of at least 10.5% in March and September as measured under the existing capital framework. This also takes into consideration: current regulatory capital minimums and the capital conservation buffer ( CCB ), which together are the total CET1 requirement. In line with the above, the total CET1 requirement for Westpac is at least 8.0%, based upon an industry minimum CET1 requirement of 4.5% plus a capital buffer of at least 3.5% applicable to domestic systemically important banks (D-SIBs) 1 ; stress testing to calibrate an appropriate buffer against a downturn; and quarterly volatility of capital ratios due to the half yearly cycle of ordinary dividend payments. Should the CET1 ratio fall below the total CET1 requirement restrictions on the distribution of earnings will apply. This includes restrictions on the amount of earnings that can be distributed through dividends, Additional Tier 1 capital distributions and discretionary staff bonuses. Westpac will revise its target capital level once APRA finalises its review of the capital adequacy framework. Westpac s capital adequacy ratios % 30 September March September 2017 The Westpac Group at Level 2 Common equity Tier 1 capital ratio Additional Tier 1 capital Tier 1 capital ratio Tier 2 capital Total regulatory capital ratio The Westpac Group at Level 1 Common equity Tier 1 capital ratio Additional Tier 1 capital Tier 1 capital ratio Tier 2 capital Total regulatory capital ratio Westpac New Zealand Limited s capital adequacy ratios % 30 September March September 2017 Westpac New Zealand Limited Common equity Tier 1 capital ratio Additional Tier 1 capital Tier 1 capital ratio Tier 2 capital Total regulatory capital ratio Noting that APRA may apply higher CET1 requirements for an individual ADI. 16 Westpac Group September 2018 Pillar 3 report

17 Capital overview Capital requirements This table shows risk weighted assets and associated capital requirements 1 for each risk type included in the regulatory assessment of Westpac s capital adequacy. Westpac s approach to managing these risks, and more detailed disclosures on the prudential assessment of capital requirements, are presented in the following sections of this report September 2018 IRB Standardised Total Risk Total Capital $m Approach Approach 2 Weighted Assets Required 1 Credit risk Corporate 69,584 1,807 71,391 5,711 Business lending 35,417 1,052 36,469 2,918 Sovereign 1, , Bank 6, , Residential mortgages 132,734 5, ,194 11,056 Australian credit cards 6,313-6, Other retail 13, ,770 1,182 Small business 16,329-16,329 1,306 Specialised lending 57, ,490 4,599 Securitisation 5,918-5, Mark-to-market related credit risk 3-6,606 6, Total 345,365 17, ,749 29,019 Market risk 6, Operational risk 39,113 3,129 Interest rate risk in the banking book 12,989 1,039 Other assets 4 3, Total 425,384 34, March 2018 IRB Standardised Total Risk Total Capital $m Approach Approach 2 Weighted Assets Required 1 Credit risk Corporate 71,590 1,861 73,451 5,876 Business lending 34, ,868 2,869 Sovereign 1, , Bank 6, , Residential mortgages 129,748 5, ,218 10,817 Australian credit cards 6,553-6, Other retail 14,056 1,013 15,069 1,205 Small business 16,017-16,017 1,281 Specialised lending 57, ,651 4,612 Securitisation 5,869-5, Mark-to-market related credit risk 3-7,019 7, Total 343,733 17, ,391 28,911 Market risk 7, Operational risk 30,866 2,469 Interest rate risk in the banking book 12,875 1,030 Other assets 4 3, Total 415,744 33,258 1 Total capital required is calculated as 8% of total risk weighted assets. 2 Westpac s Standardised risk weighted assets are categorised based on their equivalent IRB categories. 3 Mark-to-market related credit risk is measured under the standardised approach. It is also known as Credit Valuation Adjustment (CVA) risk. 4 Other assets include cash items, unsettled transactions, fixed assets and other non-interest earning assets. Westpac Group September 2018 Pillar 3 report 17

18 Capital overview September 2017 IRB Standardised Total Risk Total Capital $m Approach Approach 2 Weighted Assets Required 1 Credit risk Corporate 71,160 1,663 72,823 5,826 Business lending 34,638 1,036 35,674 2,854 Sovereign 1, , Bank 5, , Residential mortgages 127,825 4, ,610 10,609 Australian credit cards 5,665-5, Other retail 13,250 1,028 14,278 1,142 Small business 11,708-11, Specialised lending 57, ,466 4,597 Securitisation 4,167-4, Mark-to-market related credit risk 3-6,408 6, Total 332,904 16, ,258 27,941 Market risk 8, Operational risk 31,229 2,498 Interest rate risk in the banking book 11, Other assets 4 4, Total 404,235 32,339 1 Total capital required is calculated as 8% of total risk weighted assets. 2 Westpac s Standardised risk weighted assets are categorised based on their equivalent IRB categories. 3 Mark-to-market related credit risk is measured under the standardised approach. It is also known as Credit Valuation Adjustment (CVA) risk. 4 Other assets include cash items, unsettled transactions, fixed assets and other non-interest earning assets. 18 Westpac Group September 2018 Pillar 3 report

19 Leverage ratio Leverage ratio The following table summarises Westpac s leverage ratio at 30 September This has been determined using APRA s definition of the leverage ratio as specified in APS110 Capital Adequacy. $ billion 30 September June March December 2017 Tier 1 Capital Total Exposures Leverage ratio 5.8% 5.6% 5.8% 5.5% Leverage ratio disclosure 30 September $m 2018 On-balance sheet exposures 1 On-balance sheet items (excluding derivatives and securities financing transactions (SFTs), but including 845,181 collateral) 2 (Asset amounts deducted in determining Tier 1 capital) (18,337) 3 Total on-balance sheet exposures (excluding derivatives and SFTs) (sum of row s 1 and 2) 826,844 Derivative exposures 4 Replacement cost associated w ith all derivatives transactions (i.e. net of eligible cash variation margin) 10,370 5 Add-on amounts for potential future credit exposure (PFCE) associated w ith all derivatives transactions 16,617 6 Gross-up for derivatives collateral provided w here deducted from the balance sheet assets pursuant to the Australian Accounting Standards - 7 (Deductions of receivables assets for cash variation margin provided in derivatives transactions) (3) 8 (Exempted central counterparty (CCP) leg of client-cleared trade exposures) - 9 Adjusted effective notional amount of w ritten credit derivatives 6, (Adjusted effective notional offsets and add-on deductions for w ritten credit derivatives) (6,325) 11 Total derivative exposures (sum of row s 4 to 10) 27,150 SFT exposures 12 Gross SFT assets (w ith no recognition of netting), after adjusting for sales accounting transactions 1, (Netted amounts of cash payables and cash receivables of gross SFT assets) - 14 Counterparty credit risk exposure for SFT assets 4 15 Agent transaction exposures - 16 Total SFT exposures (sum of row s 12 to 15) 1,383 Other off-balance sheet exposures 17 Off-balance sheet exposure at gross notional amount 202, (Adjustments for conversion to credit equivalent amounts) (126,376) 19 Other off-balance sheet exposures (sum of row s 17 and 18) 75,752 Capital and total exposures 20 Tier 1 Capital 54, Total exposures (sum of row s 3, 11, 16 and 19) 931,129 Leverage ratio % 22 Leverage ratio 5.8% Westpac Group September 2018 Pillar 3 report 19

20 Leverage ratio Summary comparison of accounting assets versus leverage ratio exposure measure 30 September $m Total consolidated assets as per published financial statements 879,592 2 Adjustment for investments in banking, financial, insurance or commercial entities that are consolidated for accounting purposes but outside the scope of regulatory consolidation (8,931) - 3 Adjustment for assets held on the balance sheet in a fiduciary capacity pursuant to the Australian Accounting Standards but excluded from the leverage ratio exposure measure Adjustments for derivative financial instruments 3,049 5 Adjustment for SFTs (i.e. repos and similar secured lending) 4 6 Adjustment for off-balance sheet exposures (i.e. conversion to credit equivalent amounts of off-balance sheet exposures) 75,752-7 Other adjustments (18,337) 8 Leverage ratio exposure 931, Westpac Group September 2018 Pillar 3 report

21 Credit risk management Credit risk is the potential for financial loss where a customer or counterparty fails to meet their financial obligations to Westpac. Westpac maintains a credit risk management framework and a number of supporting policies, processes and controls governing the assessment, approval and management of customer and counterparty credit risk. These incorporate the assignment of risk grades, the quantification of loss estimates in the event of default, and the segmentation of credit exposures. Structure and organisation The Chief Risk Officer (CRO) is responsible for the effectiveness of overall risk management throughout Westpac, including credit risk. Authorised credit officers have delegated authority to approve credit risk exposures, including customer risk grades, other credit parameters and their ongoing review. Our largest exposures are approved by our most experienced authorised credit officers. Line business management is responsible for managing credit risks accepted in their business and for managing risk adjusted returns from their business credit portfolios, within the approved risk appetite, risk management framework and policies. Credit risk management framework and policies Westpac maintains a credit risk management framework and supporting policies that are designed to clearly define roles and responsibilities, acceptable practices, limits and key controls. The Credit Risk Management Framework describes the principles, methodologies, systems, roles and responsibilities, reports and controls that exist for managing credit risk in Westpac. The Credit Risk Rating System policy describes the credit risk rating system philosophy, design, key features and uses of rating outcomes. Concentration risk policies cover individual counterparties, specific industries (e.g. property) and individual countries. In addition, we have policies covering risk appetite statements, environmental, social and governance (ESG) risk, credit risks and the delegation of credit approval authorities. At the divisional level, credit manuals embed the Group s framework requirements for application in line businesses. These manuals include policies covering the origination, evaluation, approval, documentation, settlement and on-going management of credit risks, and sector policies to guide the extension of credit where industry-specific guidelines are considered necessary. Credit approval limits govern the extension of credit and represent the formal delegation of credit approval authority to responsible individuals throughout the organisation. Westpac Group September 2018 Pillar 3 report 21

22 Credit risk management Approach Westpac adopts two approaches to managing credit risk depending upon the nature of the customer and the product. Transaction-managed approach For larger customers, Westpac evaluates credit requests by undertaking detailed individual customer and transaction risk analysis (the transaction-managed approach). Such customers are assigned a customer risk grade (CRG) representing Westpac s estimate of their probability of default (PD). Each facility is assigned a loss given default (LGD). The Westpac credit risk rating system has 20 risk grades for non-defaulted customers and 10 risk grades for defaulted customers. Non-defaulted CRGs down to the level of normally acceptable risk (i.e. D grade see table below) are mapped to Moody s and Standard & Poor s (S&P) external senior ranking unsecured ratings. This mapping is reviewed annually and allows Westpac to integrate the rating agencies default history with internal historical data when calculating PDs. The final assignment of CRGs and LGDs is approved by authorised credit approvers with appropriate delegated approval authority. All material credit exposures are approved by authorised Credit Officers who are part of the risk management stream and operate independently of the areas originating the credit risk proposals. Authorised Credit Officer decisions are subject to reviews to ensure consistent quality and confirm compliance with approval authority. Separate teams are responsible for maintaining accurate and timely recording of all credit risk approvals and changes to customer and facility data. These teams also operate independently of both the areas originating the credit risk proposals and the credit risk approvers. Appropriate segregation of functions is one of the key requirements of our credit risk management framework. Mapping of Westpac risk grades The table below shows the current alignment between Westpac s CRGs and the corresponding external rating. Note that only high-level CRG groupings are shown. Westpac customer risk grade Standard & Poor s rating Moody s rating A AAA to AA Aaa to Aa3 B A+ to A A1 to A3 C BBB+ to BBB Baa1 to Baa3 D BB+ to B+ Ba1 to B1 E F G H Westpac Rating Watchlist Special mention Substandard/default Default For Specialised Lending Westpac maps exposures to the appropriate supervisory slot based on an assessment that takes into account borrower strength and security quality, as required by APS 113. Program-managed approach High-volume retail customer credit portfolios with homogenous credit risk characteristics are managed on a statistical basis according to pre-determined objective criteria (the program-managed approach). Programmanaged exposure to a consumer customer may exceed $1 million. Business customer exposures may be program managed for exposure up to $3 million. Quantitative scorecards are used to assign application and behavioural scores to enable risk-based decision making within these portfolios. The scorecard outcomes and decisions are regularly monitored and validated against subsequent customer performance and scorecards are recalibrated or rebuilt when required. For capital estimation and other purposes, risk-based customer segments are created based upon modelled expected PD, Exposure At Default (EAD) and LGD. Accounts are then assigned to respective segments based on customer and account characteristics. Each segment is assigned a quantified measure of its PD, LGD and EAD. For both transaction-managed and program-managed approaches, CRGs, PDs and LGDs are reviewed at least annually. 22 Westpac Group September 2018 Pillar 3 report